MEXICO'S MAKEOVER (int'l edition)

Five years after NAFTA, the country is turning into an industrial power, whose
workers and exports are becoming increasingly sophisticated

Surfing for clients on the Internet, a Mexican entrepreneur in Monterrey has turned a small metal-working company into a $10 million-a-year exporter to General Electric Co. and Siemens in just five years. In Guadalajara, a 26-year-old high school graduate earns more than $500 a month inspecting silicon components that will help power IBM computers around the world. Across the country, in the city of Puebla, 15,000 Mexican workers churn out Volkswagen's new Beetle for export to the world, including Germany.

Mexico's economy is undergoing a stunning transformation. Five years after the launch of the North American Free Trade Agreement, it is fast becoming an industrial power. Free trade with the U.S. and Canada is turning the country from a mere assembler of cheap, low-quality goods into a reliable exporter of sophisticated products from auto brake systems to laptop computers. Since 1993, exports have more than doubled, to $115 billion. Manufactured goods now make up close to 90% of Mexico's sales abroad, up from 77% five years ago.

Oil, by contrast, is now 7% of exports, down from 22% in 1993. Mexico's manufacturing sector pulled the economy along at 4.5% growth this year--even though the government still depends on oil for 35% of its budget revenues. President Ernesto Zedillo has been forced to slash spending and raise taxes to make up for the shortfall. That squeeze could slow growth to 2.5% next year, economists say, and helps explain why Mexico's bolsa is down 40% this year in dollar terms. Still, NAFTA has helped protect Mexico from both the plunge in oil prices and the fallout from the global emerging-markets crisis. ''This is a completely different economy than Mexico had a decade ago,'' says sociologist Federico Reyes Heroles.

Mexico's industrial surge also means that North America is winning back thousands of jobs that had been lost to Asia as U.S. and Canadian companies shifted production to lower-cost production sites in the last decade. Now, for example, IBM is making computer components in Guadalajara formerly made in Singapore. And clothing retailers such as Gap Inc. and Liz Claiborne are increasingly buying garments from Mexican contractors, who can offer faster delivery than Asians.

The shift back from Asia is just part of a boom of foreign investment in Mexico. Not only American and Canadian companies but also European and Asian multinationals have been pouring billions into Mexico's economy. As companies from Samsung to Daimler Benz to DuPont open factories or expand existing operations, foreign direct investment has soared from $4 billion in 1993 to an average $10 billion per year. Moreover, the foreign units are no longer mainly maquiladoras, assembly plants huddled along the U.S.-Mexico border. Now, many are more sophisticated factories scattered throughout the country.

The foreigners are attracted by Mexico's low-cost labor--averaging $1.60 an hour in manufacturing, compared with $6.11 in Taiwan and less than 40 cents in China--and by duty-free access to the U.S. market. But just as important, NAFTA guarantees foreigners the same rights as Mexican investors and reassures them that Mexico will continue on its free-market course. That's one reason foreign investors kept coming even after the peso collapse of 1994. ''When we invest, we consider political stability,'' says Young M. Kwon, president of Samsung Electromechanics in Tijuana. Adds Commerce & Industry Secretary Herminio Blanco: ''Now, Mexico is viewed by the world as a strategic place to invest.''

SCATTERED BENEFITS. But the makeover of Mexican industry goes far beyond export and investment numbers. From small entrepreneurs to executives of the country's new multinationals, Mexican managers are becoming more confident as they respond to heightened competition at home and to the tough demands of foreign customers. Through joint ventures with foreign companies, Mexican executives are becoming more accountable to shareholders. ''The North American Free Trade Agreement has given Mexicans a new vision of the world,'' says Clemente Ruiz Duran, an economist at the National Autonomous University of Mexico.

To be sure, Mexico still faces tremendous problems. Indeed, it seems there are really two Mexican economies, with free trade benefiting only one. Despite a sharp increase in manufacturing employment, Mexico still suffers from a chronic shortage of jobs, with millions subsisting on part-time work in the ''informal'' economy. That's partly because the 1995 recession wiped out 2 million jobs. Mexico needs to generate 1 million new jobs each year just to absorb young people entering the job market. To achieve that will require even more investment and better training. ''We're still waiting to feel all these benefits from NAFTA,'' says Francisco Hernandez Juarez, a prominent labor leader who initially supported NAFTA but now feels disappointed.

Nevertheless, Mexico is laying a solid foundation for economic growth and employment in the years ahead. Around cities such as Guadalajara and Puebla, where protected industries once turned out goods strictly for the local market, new factories are humming. Many plants are producing high-quality versions of goods Mexico had already been known for--auto parts and electronic components, for example. But increasingly, local engineers are designing the products and testing them in multimillion-dollar research and development centers. NAFTA has nurtured an elite new class of skilled Mexican workers who earn up to two-thirds more than the average $13 per day for Mexican factory workers.

NAFTA has also given a boost to more traditional industries. Furniture exports, for example, have risen by more than 25% annually since 1995. Agro-industry is gaining momentum, with exports of frozen products to markets as far away as Sweden. And Mexican service businesses are processing U.S. credit-card data and airline tickets as well as creating custom-made software for U.S. corporations that once farmed out such work to programmers in India.

MASS MIGRATION. But the auto industry stands out as Mexico's single most important manufacturing business. It has become integrated with the U.S. industry as parts and vehicles shuttle back and forth across the border. More than 500,000 Mexicans now make parts and assemble vehicles for eight of the world's biggest auto makers, including Detroit's Big Three. NAFTA's rules of origin, requiring high North American-made content in cars, have forced European and Asian auto makers to bring their foreign parts suppliers to Mexico as well as buy from local companies. That has given a boost to cities such as Puebla, 125 kilometers east of Mexico City. There, 70 parts makers cluster around Volkswagen's sprawling plant, which produces 600 new Beetles and 900 other VW cars per day.

One major supplier is Sommer Allibert Duroplast, a French-Mexican joint venture with $70 million in 1998 sales. It employs 950 workers producing plastic instrument panels, consoles, and doors for the Beetle. General Manager Faustino Franco Rech, a Spaniard, says his goal is to ''nationalize our suppliers to the maximum--the more we buy in Mexico, the better.'' Next door is Refa Mexicana, a metal-stamping plant started by Canada-based entrepreneur Klaus Reithofer four years ago with a $4 million investment. Today, he employs 1,300 people working three shifts and generating $57 million in annual sales to VW and others. ''We were only supposed to be 130 people, but VW has thrown so much stuff at us, and we took it,'' he says. ''It's miraculous.''

Similar explosive growth is happening in the electronics belt around Tijuana on the U.S. border. South Korea's Samsung plans to spend $150 million to expand production of color picture tubes at its 4,500-employee complex, which currently makes TV sets and computer monitors worth $900 million annually, mostly for export to the U.S. Samsung and other TV makers have brought some 45 Korean suppliers over the past four years to the border area.

These days, much of the electronics production is spreading south to Guadalajara, the country's second-largest city. A joint government-business effort has lured 25 suppliers to set up shop in the city since 1995. Taiwan's Universal Scientific Industrial Co. (USI) this year began producing 2,900 computer motherboards daily for IBM in a new plant employing 270 people. Before, the boards were shipped in from Taiwan.

At the huge IBM complex nearby, 26-year-old Ivette Cruz peers into a microscope, searching for defects in silicon wafers that are part of magnetic readers for computer hard-disk drives. A high school graduate, she hopes to participate in an IBM program that will pay her tuition to earn an industrial engineering degree at night school. ''I always saw this as being a career with a real future,'' she says. More than 7,000 employees of IBM and its subcontractors work at the plant.

The parts used to be made in Singapore, Taiwan, and Malaysia. Now, IBM's Guadalajara plant produces and ships them by air each day to a plant in San Jose, Calif., where hard drives are assembled for IBM's laptops, desktops, and servers worldwide. Plant Manager Alfonso Alva Rosano says NAFTA helped persuade IBM to shift some operations from Asia to IBM de Mexico, which in five years has boosted exports from $350 million to $2 billion. ''If we weren't making the subassemblies here,'' Alva Rosano says, ''chances are the whole process would have moved to the Far East.''

SHORTER JOURNEY. Textiles are another Mexican industry bringing factories and jobs back from Asia. NAFTA rescued Mexico's outmoded, declining textile makers by eliminating U.S. tariffs and quotas on fabric and garments made with yarn produced anywhere in the three member countries. In 1996, Mexico overtook China as the largest supplier of textiles and garments to the U.S. Now, Mexico is going a step further by producing not only garments but also high-quality textiles--and U.S. mills are rushing to invest. In the port city of Altamira on the Gulf of Mexico, for example, Guilford Mills Inc., based in Greensboro, N.C., is building a $100 million knitting, dyeing, and finishing plant. DuPont and Mexican partner Alpek are building a polyester plant nearby.

Far from being crushed by the invasion of foreign investors, many Mexican textile makers are staying competitive by investing in technology. The change is visible in Puebla, Mexico's traditional textile center. Skytex, a company set up by several Mexican families to make polyester fabric in a factory financed by a Japanese equipment supplier, exports half of its monthly production of 2 million yards to the U.S. ''This plant was conceived for NAFTA,'' says Deputy Sales Director Alberto Serur. ''I can ship to the border in 18 hours, while the Asians take 21 days.''

NAFTA's rules favoring North American-made garments are helping some economically depressed areas. More than 140 plants, mostly garment makers, have located in Yucatan and Oaxaca states, which previously had little industry. But for many small Mexican companies, high borrowing costs are a barrier to upgrading technology. Big corporations with access to cheaper foreign financing have reaped the lion's share of the benefits of Mexico's industrial surge. ''You're clearly concentrating power in the top producers that have financial power,'' says Raul Hinojosa, a professor of public policy at the University of California at Los Angeles. A NAFTA study led by Hinojosa found that the top 50 companies account for one-half of Mexican exports and for the bulk of recent export growth.

Still, there are signs that smaller companies are learning how to sell their wares abroad. Before NAFTA, 21,000 Mexican companies exported their goods. Today, that number has risen to 33,000, says Commerce Secretary Blanco. Industrial de Fosfatos, a producer of fire-extinguisher chemical powders with 100 employees in Ciudad Victoria in the northern state of Tamaulipas, is one company that has carved out a global niche. Exports to the U.S., Europe, and Asia account for 85% of sales, which rose to around $13 million this year from $8.5 million in 1993. General Director Fernando Macedo Balboa estimates that Fosfatos has 18% of the world market. Although tariffs on Fosfatos' products were low even before the free-trade accord, Macedo believes NAFTA has created greater confidence in

In fact, Mexican managers are now seeing themselves differently. In the top ranks of Mexican businesses, many executives say they now consider their companies to be North American corporations. Take Monterrey-based Grupo IMSA, a $1.5 billion maker of steel, auto parts, and construction products. In the past few years, IMSA has bought four plants in the U.S. and is building a fifth. It makes auto batteries with Johnson Controls, ladders with a unit of St. Louis-based Emerson Electric, and prefabricated building components with Varco-Prudem, a division of steelmaker LTB. Forty percent of the group's sales now come from its manufacturing operations outside Mexico plus exports. ''For us, NAFTA is a single market--we feel we're an American company,'' says Eugenio Clariond Reyes, Grupo IMSA's general director.

WAGE GAP. Today, polls show that most Mexicans--even leftist politicians who opposed the free-trade treaty--believe that NAFTA has benefited the country. But free trade is also exposing more starkly than ever some of the failures of Mexican society, particularly in education. Many analysts believed NAFTA would generate years of demand for Mexico's masses of unskilled, poorly educated workers, who average only 5 1/2 years of schooling. Instead, many employers are leapfrogging to high-tech operations that require a high school education even for assembly-line operators. Since 1993, the gap has widened between wages at local manufacturers and those at top export manufacturers, which are up to 67% higher.

For the coming decade, labor-intensive assembly tasks will have to provide employment for many of Mexico's millions of job-seekers. But ''for Mexico to prosper, it's not enough to be a manufacturing country,'' says Jaime Reyes, 50, who heads Hewlett-Packard Co. in Mexico. ''There's no better way to be viable than by designing our own products with our own technology.'' That's what his team of 30 engineers is doing. They're in charge of designing paper input mechanisms for HP LaserJet printers worldwide. The next step will be for more Mexican-owned companies to do more R&D with their own resources.

No doubt, Mexico has achieved a lot in five years. It already exports twice as much as Brazil with an economy half as big. Its new efficiencies and export mentality should help diversify its trade beyond NAFTA, with Latin America and the rest of the world. ''Businesspeople are looking outside the country and into the future,'' says political scientist Luis Rubio of the Center of Research for Development, a Mexico City think tank. For companies that have succeeded in Mexico's open market, ''it's no longer, 'Those darn gringos,''' Rubio says, ''but 'How can we beat them at their own game?''' In a dog-eat-dog global economy, that kind of attitude should serve Mexicans well.